The IRS has issued, effective today, final regulations for trusts and estates to follow on the proper treatment of expenses subject to the 2% floor for miscellaneous itemized deductions.
Individuals and fiduciaries must reduce certain expenses, and not deduct the full amount, under IRC §67(a). These expenses include tax preparations fees, professional dues, home office expenses, and investment costs. IRC §67(e) says that expenses incurred by a trust are not limited if they “would not have been incurred if the property were not held in such trust or estate”. There has been must discussion about what expenses “would not have been incurred”.
The issue was litigated and reached the US Supreme Court who said (in 2008) that investment advisory fees incurred by trusts ARE subject to the 2%-floor limitation. Around that time, the IRS released temporary regulations regarding the deduction of certain expenses by trusts and estates. Those regulations are final and effective as of last Friday (May 9, 2014).
The final regulations confirm that trusts and estates must subject expenses to the 2%-floor limitation any miscellaneous itemized deduction which “commonly or customarily would be incurred by a hypothetical individual holding the same property” [see Reg. §1.67-4(a)].
The regulation’s next section elaborates on the meaning of “commonly” and “customarily”. It discusses costs considered “ownership costs” (which are generally subject to limitation since an individual would incur the same costs); “tax preparation fees” (which EXCLUDE from limitation the cost of estate tax returns, all fiduciary income tax returns, and a decedent’s final Form 1040); “investment advisory fees” (which are generally subject to limitation, except for advice specifically identifiably as not likely to be incurred by an individual); and “appraisal fees” (which exclude from limitation the costs associated with appraisal’s for an estate’s or trust’s income tax return, or a GST tax return).
Other costs which are fiduciary in nature are not subject to the limitation; these include probate court fees and costs; fiduciary bond premiums, and other costs listed in the regulation. Not mentioned, but not subject to limitation, are trustees fees.
Finally, the regulation addresses the problem of bundled fees. If a trust or estate pays a single fee for services which are subject to limitation and services which are not subject to limitation, then the single fee must be separated and the appropriate part made subject to the limitation. The regulation permits any reasonable method of allocation to divide the single fee.
The final regulation apply to tax years beginning on or after May 9, 2014. Previously issued (temporary) regulations have been removed. IRS Notices issued in 2008, 2010 and 2011 have been superseded by these final regulations.
See: TD 9664